Tuesday, August 9, 2016

It's hard to pay much attention to one quarter's productivity, just as it is hard to get excited about one month's jobs number. But when productivity is consistently weak over several years, then we can be sure there is a big problem. Productivity in the second quarter was a miserable -0.5% annualized, right in line with -0.4% over the past year, and worse than the 0.4% annualized over the past two years and 0.5% over the past five years. We haven't seen such poor productivity numbers since the late 1970s, when high inflation, a weak dollar, and foreign policy disasters created a multi-year malaise. We have a big productivity problem, and it stems from a lack of business investment, pervasive risk aversion, crushing regulatory burdens, and a general anti-business, anti-growth sentiment emanating from the White House.

The chart above shows the 2-yr annualized change in the productivity of U.S. non-farm workers. This is a pretty reliable measure of the current climate, much more reliable than the quarterly productivity numbers which are notoriously volatile.

The chart above goes one step further, measuring productivity over 5-yr periods. This highlights fundamental, long-term changes in productivity. The chart also shows how productivity has behaved during different presidential administrations. The Obama years have been miserable, which is another way of saying that the current business cycle expansion has been the weakest in post-war history.

The US economy desperately needs a return to pro-growth policies. If we were to excise trade-related issues from Trump's economic policy speech yesterday, it would be an excellent remedy to what has been ailing the U.S. economy for years. Certainly far better than Hillary's proposals, which amount to doubling-down on all the mistakes of the Obama years (e.g., higher taxes, more income redistribution, more regulations).

The bad news, then, is that we have been suffering from anti-growth policies for a long time, and it's been getting worse on the margin. The good news, however, is that this means there is a deep reservoir of untapped potential in the US economy. If the political winds in the next several months start blowing in a more pro-growth direction, the stock market would be fully justified in extending the bull market which began over seven years ago.

UPDATE: John Taylor offers a more detailed, but similar, explanation for why productivity has been so weak here. HT: reader "Hans."

UPDATE: John Cochrane has nice essay on why productivity is essential for wealth generation and growth here.

Productivity gains are a lot more attainable in a manufacturing economy, but not so easy in a service economy which is people dependent. The increase in productivity from technology in the service sector has about run its course until drones, driverless cars or other technology become a reality, not really dependent on government regulation which impact profit but not productivity. If anything, government regulation gives business incentive to do as much as possible without employees.

Again, I wish for mention of property zoning--it is suffocating growth on the West Coast. Try attracting an employee to California. Trying renting space. Why not legalize truck businesses Begrudgingly, some cities have legalized food trucks. But why not clothing trucks or book trucks, or any consumer items the public wants? Push-cart vending would open up millions of business opportunities to epode without much capital.

We like free enterprise except when we don't.

I agree that Trump's economic proposals are at least in the right direction, though one man's "unnecessary regulations" are another man's common sense.

How many people want to deregulate property zoning--in their own neighborhood? The air is much cleaner in L.A. than 50 years ago, and one can see across the street, even on a summer day. Is poisoning the air other people breath something we can wink at?

On foreign trade: Fear not too much. The most ferocious protectionist in recent U.S. history was….Ronald Reagan.

Said Cato Institute in 1988 (before hagiographers set in):

"By this standard, the Reagan administration has failed to promote free trade. Ronald Reagan by his actions has become the most protectionist president since Herbert Hoover, the heavyweight champion of protectionists."

http://www.cato.org/pubs/pas/pa107.html

In fact, Reagan may have been a bigger protectionist than Hoover. The famed Smoot-Hawley tariffs were often toothless.

In contrast, Reagan put a 100% tariff on Japanese electronics, and 50% tariff on other goods, and numerical ceiling on Japan auto exports the US, among many, many other measures. At the Plaza Accords in 1986, Reagan pushed down the official exchange rate of the US dollar. He was a currency manipulator and above-board about it!

But, as we see from Scott Grannis' charts above the 1980s were okay. Productivity rose nicely.

The big problems today are suffocated demand, and artificial scarcity of property. The global central banks are too tight, and property zoning become an obsolete straitjacket.

I like helicopter drops with a 10-year moratorium on property zoning. I bet we would see good development and business growth.

What I can't understand is that Trump is running against two establishments: The Democratic establishment...and the GOP establishment.

That makes Trump completely appealing. He would win this election in a landslide if he had not shot himself in the foot so many times with unnecessary alienating comments.

Mr Grech, if few Americans care about theConstitution and the Bill of Rights, then we have become just another modern state.

With this massive regulatory burden placed upon the American free enterprise system, by both the Bushnecks and Barrocko, is there little wonder asto why we are seeing sub par growth and the nexusof very poor productivity.

Capital has begun to flee the USA and I am afraidthe momentum will continue accelerate.

Animal spirits continue to be in the toilet despite continued new highs. And I don't think there's much mystery - it's due to all the things Scott and Benjamin have been talking about for years. There's too much regulation, especially environmental regulation (of which zoning laws are a cousin).

Reagan was wildly overrated as a president but his administration gave us more economic certainty, not less.

As one example of how sclerotic our politics have become... We all know our infrastructure is in desperate need of improvement. But is there one among us who believes it could be done without monstrous waste? Obama kind of proved it can't.

On an older thread... While I believe the republic has fallen, it's not like Armageddon is upon us. I think we've become something like Europe (pathetically slow growth, dominated by know-little elites) with a militaristic bent.

The last datapoint in the chart shows the annualized change in productivity for the 5 years ending June '16. Surely that fully reflects the result of the policies of the Obama administration which began a little over 7 years ago (i.e., I assume there is a lag between when policies are implemented and when their results are reflected in economic activity, and that lag could arguably be about two years, possibly less).

Scott, have loved your blog postings over the past 3 years now. What are your thoughts on latest doomsday bubble propaganda ($559+ Trillion in derivatives) leverage held by the big 5 or 6 banks (Citigroup, JPM, GS, B of A, MS, DB) and that we will see a market crash of biblical proportions? I tend to read all the doomsdayers as a contrarian trader to what is really going to happen, but would love your perspective on this and the bond market supposed bubble. Cheers.

Whenever you see reports that claim hundreds of trillions of dollars of derivative leverage you have to do two things: 1) realize the number is grossly distorted and 2) discount the number by 98% or so. There is no way that major banks have derivative positions that total over 500 trillion. The true number could easily be in the many trillions, but even then it is a notional amount, and not a net amount. The problem with derivatives is that banks put on one position with counterparty A and then lay off most or all of that position with counterparty B. The bank has very little effective exposure (if any) because the two positions hedge each other. But the bank can't report a net exposure because the two sides of the transaction are not technically equal. It's different with futures contracts, because one position can exactly offset another and the net is zero. But over-the-counter derivatives (which are mostly done through major banks) cannot be netted out from an accounting standpoint. However there are elaborate safeguards to ensure that exposures are hedged or collateralized on a daily basis. The banks are not going to destroy the world with derivatives.

If I told you that in nation X, 10-year government bond yields had fallen to 1.50% and homeownership rates to the lowest levels in 50 years, and that the central bank had established a 2% inflation target but constantly missed on the low side, would you say, "Nation X has a too-easy monitor policy"?

Inflation and interest rates have been on a downward path for 30 years. How is this easy money?

I think there us a mistake being make, and that is the judge monetary policy by the past.

For example, for any nation, is a 1,000,000-man army too big or too small? Neither--it depends on the threat levels.

Benjamin, I've been reading your "easy money" verbiage for ages now and respectfully I think you have it exactly wrong. The problem isn't the lack of easy money and as proof just consider the lack of productivity with a ZIRP. The problem is exactly as Scott has put it, an extremely anti-business administration with no accountability (since government NEVER has any) and a reliance and focus on the slightest machinations of the Fed by business execs. I can virtually guarantee that IF our federal government was more business friendly aka less corporate tax and less reg THEN there would be far less consideration to what the Fed was up to. The shame of it is the average American voter hasn't a CLUE about these issues and that is why we have a bully Vs a liar.

Hillary will do everything economic conservatives fear. We will become even more like Europe. The rich will get richer (particularly the Clintons) and those dependent on government support will increase - permanently. In my view, conservatives have done this to ourselves, perversely culminating in the selection of Trump as candidate. Still, serious conservative thinkers are wringing out reasons why he's better than Hillary. It should be clear that we can have no clue what he would do, no matter what he says now. The odds that his impulsive,ill-informed actions will have tragic results far outweighs the odds that he might luck in to something good. I'll live with Hillary and hopefully the catharsis of this conservative moment turns to something better in the future.

Randy, Total agreement with every word you wrote. Additionally, odds favor a very significant recession in the relative near future simply due to the fact that congress/administration will do nothing salutary and the Fed has limited arrows in its quiver. Give it to Hillary and let the left take the heat.

Re: whether money is easy or tight. Core CPI inflation has been on a 2% flat trend for the past 13 years. Core PCE deflator has also been in a flat trend since 1997, averaging about 1.6-1.7% per year. The fact that the core PCE deflator is 35 bps lower than the Fed's ostensible target does not prove that the Fed is too tight. If the Fed were too tight core inflation would be trending lower, but it is most definitely not. Inflation has been positive for decades and continues to be. If the Fed were too tight the dollar would be rising, but it has been in a flat trend for more than a year; gold would be falling (as would most commodities), but it is instead rising; credit spreads would be high and rising, but they are low and falling.

The fact that economic growth has been sluggish for seven years does not prove that the Fed is too tight. There is no shortage of culprits for slow growth (e.g., high taxes and regulatory burdens). In any event, monetary policy has no power to create growth out of thin air; only productivity creates growth.

I see no evidence at all that monetary policy is too tight. In fact, I think it's easy to demonstrate that the Fed has been doing a pretty good job, as evidenced by low and stable inflation.

Assuming that Mr. Orange's policies make sense (I think they would produce crushing debt like Sam Brownback's writ large), his personality is so unstable (and his foreign policy so dangerous) that I wouldn't vote for him even if I was able to handpick economists to devise his policies.

Scott/Steve-- well maybe I am wrong and money is not too tight. But I prefer a 3% inflation target.

And I have yet to see either party truly embrace regulatory reduction. Show me the party that wants to get rid of ethanol fuel, eliminate property zoning. Eliminate rural subsidies. Reduce "national security" outlays. Wipe out the USDA. Shutter HUD. Does the Department of Commerce actually do anything?

Many people say they like food trucks. But why limit commercial activity from a truck to food? Why not allow trucks to sell books, consumer items, jewelry--anything that would sell from a truck?

We should decriminalize push-cart vending to the maximum extent possible.

What we get from the GOP is a lot of talk about deregulation that affects large commercial enterprises, but never actual proposals about regulations that prevent individuals from starting businesses.

The Donks are worse.

And seeing the GOP-neocons migrate to Hillary's Camp confirms my suspicions she is but a warmonger in pantsuits.

Re: The argument about the Fed and inflation... The points made on this thread underscore the idea that lousy fiscal policy is the main detriment to better economic growth. Steve made this point and Benjamin agrees.

But while the Fed may not be too tight at this moment, don't let the FOMC off the hook so easily. One need only look at a ten-year chart of the gold price to realize how piss-poor this Fed has been. The sheer volatility in the price of gold means that the Fed has failed in its mandate for stable monetary policy. Scott and others argue that the price of gold can be pushed around in the short term, and that's true perhaps. But over a long period of time it becomes evident that the Fed has been pretty awful. Stable money should result in a much flatter gold price.

Even if you look at TIPS spreads over time - the market's call on future inflation - the volatility has been way too high. (Be suspicious of CPI readings due to measurement issues.)

This volatility has a pernicious effect on business transactions. Too easy money is a boon to borrowers; too tight money is a boon to lenders. When both sides are rightly fearful that they'll get hosed by the Fed, the volume of borrowing/lending suffers. (And, boy, are we seeing that these days. I know there are other factors but to dismiss the role of the Fed is wrong.)

The near-term case for complaining about the Fed was much stronger last year when they idiotically made the case for raising rates while gold and every other meaningful stat was signaling that deflation was the problem. To their credit, they reversed course hard. So things are better now. But the worry of monetary volatility hasn't abated at all.

We desperately need better fiscal policies. But monetary volatility - of which the Fed is responsible - is contributing to our economic malaise.

(Btw, I am a fan of 0% inflation, not 2% or 3%. Inflation destroys purchasing power. And the only people who can defend against it are the rich, the people with assets. The working class and the poor cannot. Over time, even 2% inflation has an incredibly harmful effect on society.)

Yes, the Palo Also story has been making the rounds. In a dispiriting fashion, by my lights.

This reinforces the right-wing bias that the problem is pointy-headed liberals in Northern California, and the fix is just better zoning, not no zoning.

As I have pointed out many times, just try building a 50-story condo tower in Newport Beach. Or go to Connecticut outside New York City, and try to develop houses, when there is a two-acre minimum lot size.

Beyond that, is there not such a thing as property rights? Really, when any city can downzone your land? This happened all over Orange County in the past two decades.

Granted, one cannot emit carcinogens or make loud noises continuously---but we tell people how they can use their land in great detail. No retailing. What size signage. No manufacturing. No livestock. Even if you can have a lawn or not in your front yard.

Dudes, let's just clear the books. No property zoning. It is a violation of your property rights. It inhibits commercial development beyond whatever gains there are. Property zoning has resulted in artificially high rents and house prices all through the West Coast.

Silver has a longer lineage as a monetary metal. Forgotten today, the real metallic treasure the Spaniards brought back from the New World was not gold, but large amounts of silver and that from incredibly rich silver mines. (The "real gold" they brought back was potatoes and other New World foods, but that is another story).

Silver was the bank metal and coinage in China while gold was still regarded as gaudy jewelry. In fact, the name for "bank" in Chinese is "silver house." Old Chinese literature refers constantly to silver.

Gold prices are a funny one. The People's Bank of China has been buying gold. It is one way to lower the exchange value of the yuan. China and India are by far the biggest markets for gold. They have their own central banks, and tax policies regarding gold, and huge gold jewelry markets.

The Fed and gold? How about the Fed and silver? Platinum? Palladium? OIl?

Oil is trading now for less than it did in 1979. The incredible innovation of the shale-oil boys, plus wonderful improvements in MPGs by automakers, have cratered oil prices. The Fed did this? Or not?

Dr. Copper? Cut in half in last five years, and I think it was Goldman Sachs or Morgan Stanley who just predicted another price crack in H2.

If the Fed is so loose, why Dr. Copper a homocide victim?

I enjoy your commentary Matthew and I am not insisting I am right. I just puzzle over the connections between the Fed and the prices of some commodities, in globalized markets.

Dr Ed Yardini's less political explaination of the "Productivity Puzzle":

"...On the other hand, productivity in the services economy continues to lag productivity in manufacturing, which has been much easier to automate. That may be starting to change, but most of the employment gains have been in services for many years, and the lackluster pace of productivity may simply reflect that most service industries still rely on workers more than automation to deliver their services.

"Another possible explanation is that, from a supply-side, companies are highly productive. The problem is that in a world of secular stagnant demand growth, their unit sales aren’t strong enough to show off their productivity. You may have the most efficient widget factory in the world, but if no one wants widgets, your productivity is zero. Consider the following:

"(1) Lots of capacity. There are lots of industries and companies with too much unproductive capacity. Some have expanded too much with the help of cheap credit. Some have been disrupted by competitors using new technologies. I just can’t find too many industries that haven’t spent enough money on plant, equipment, and technology. Indeed, the industrial capacity utilization rate has dropped to 75.4% during June from a recent peak of 78.9% in November 2014. What’s puzzling is that the employment rate (which is the flip side of the official unemployment rate) has risen to 95.1% from 94.2% over this same period.

Yardeni's explanation for the lack of productivity in the service sector doesn't make sense to me. Ultimately, we can only demand what we supply. If there is an alleged "shortage of demand" what it really means is that the problem is not that people are not consuming enough, it means that there is a shortfall of production of goods and services. The service sector may not be suffering from a lack of demand, but it is most likely suffering from a lack of productivity. The service sector constitutes the vast majority of the economy; if the productivity of that sector is weak, then by definition the demand for the output of the economy will be weak. The only way an economy can grow is for the output of the average worker to increase.

"Weak demand" is what Keynesian economists love to argue is the problem. And politicians love it as well, because that gives them an excuse to take money from "the rich" and give it to "the poor," because, they allege, the rich are no spending enough and the poor will surely spend all that is given to them. The problem, of course, is that you can't grow the economy by taking from one person and giving to another. In reality, doing so just weakens the economy by creating disincentives to work.

I look at silver too. But everything I said about gold applies to silver, as well. Specifically, the volatility of monetary policy can be seen in both the long term chart of gold and the long term chart of silver. This is not a surprise since gold and silver are very closely linked, obviously. Of the two, though, gold is the purer representative - over time - of the relationship between the money supply and money demanded. This is so because gold has even fewer commercial uses than does silver.

As for other commodities, they are all less good at explaining the relationship between the money supply and money demand. This is due to productivity enhancements (think fracking) and substitution effects. But in any event, disparities in movements between commodities can take a very long time to come back into balance, many years in some instances.

I never claimed the Fed was loose. I just noted that they were less tight than they were in the second half of 2015. This is beyond debate as commodities, including gold and silver were if freefall back then, as were TIPS spreads.

I too very much enjoy your commentary. It really rounds out the consistently good commentary from Scott. I also very much admire your basic posture with respect to the Fed; that is, you're far more right than wrong when you constantly point out that worries over inflation - a staple of the Fed and a relic of most of the history of the 20th century - are misplaced. You seem to be far more consistent with Scott Sumner in being open-minded to nominal GDP targeting, as am I. In any event, I like to regularly point out that the monetary volatility that the Fed creates has a pernicious effect on economic growth as well as a long term ill effect on society (because it exacerbates the gulf between the rich and poor which, in turn, must have deep political implications).

"Dudes, let's just clear the books. No property zoning. It is a violation of your property rights. It inhibits commercial development beyond whatever gains there are. Property zoning has resulted in artificially high rents and house prices all through the West Coast."

Ben Jamin, I concur completely: Unfortunately, there are toomany volks with a vested interest.

The current solution will be more GUs intervention, the samefailed clowns whom created the problems.

Is it possible to setup free mandate zones, which would eliminate all social engineering ?